Bypassing voter approval for public debt backfires

The recent announcement that the prison complex known as Colorado State Penitentiary II will be closing its doors in 2013 provides a good lesson in what happens when politicians and bureaucrats bypass the traditional funding restraints derived from the democratic process. It is an expensive lesson to be sure.

What should have happened, but didn’t, is that in 2003, when the state legislature decided it wanted to build yet another prison, the state should have been forced to put a $160 million bond issue on the ballot for voter approval. The politicians didn’t do this because by 2003 they knew that such a ballot issue would most likely have failed.

Beginning in the late 1980s, more and more municipalities and states began to have trouble getting voter approval for their bonds, particularly bonds aimed at prison construction. In one state after another, including Colorado, voters began to say “no” to the largest prison expansion in history. This prison boom started in the early 1970s and accelerated through the next two decades, thanks primarily to politically expedient hard-on crime legislation such as “truth in sentencing,” “three strikes” and the “war on drugs.”

Increasingly, taxpayers understood that building more and more prisons was siphoning off funds for things like higher education, child welfare programs and infrastructure. By the end of the Reagan administration, it was a tradeoff they had become unwilling to make, and they began voting down funding for the prison expansion.

This clear action to deny funds for the expansion should have brought it to an end and forced a more restrained approach to criminal justice, with a greater emphasis on cheaper alternatives to prison such as alcohol and drug rehab programs, closely supervised parole and electronic monitoring.

But a funny thing happened when investment bankers like Goldman Sachs and politicians came face to face with voter-enforced fiscal restraint — they ignored it by inventing, or at least repurposing, a variety of funny paper with names like “Lease Revenue Bonds” and “Certificates of Participation” (COPs). By using these financial instruments in never-before-heard-of ways, those who profited either financially or politically by building more prisons were able to continue to create and sell investment-grade debt without voter approval. It was political sleight of hand at its best. By changing the name of the financial instruments from bonds to COPs, the debt no longer had to be shown as debt on the books, so voter approval was no longer required.

It works like this. A $100 million bond to be repaid with interest over 25 years is a debt. Investors buy the bond, then the state or municipality uses the money to build the prison. The state is obligated to pay back the money no matter what. To raise $100 million through the sale of COPs, the state promises to lease the prison from a nonprofit entity created to sell the COPs to the investors whose money is actually used to build the prison. So the state figures out how much it would cost if it were paying off a 5 percent interest bond over 25 years and divides the total payout by 25. It then agrees to pay that amount per year as a lease payment for 25 years to the holders of the COPs. At the end of 25 years, the COP holders agree to deed the prison to the state. Because the state has to reauthorize the lease payment each year, it is legally not considered debt, and thereby no voter approval is needed.

What started as a novel process to occasionally bypass voters when politicians thought they knew best has now become a multi-billion dollar industry that empowers the investment class to suck up profits at the taxpayers’ expense on one illadvised building project after another.

Consider Colorado State Penitentiary II.

In 2003, legislators passed HB 1256, allowing them to bypass voters and sell $162 million worth of COPs to construct the 948-bed prison in Caņon City. The prison finally opened in 2011 with about one-third of the beds being used.

However, between 2003 and 2011, the state of Colorado hired an outside consultant to help it re-evaluate some of its practices. As a result of changes in policy around the use of administrative segregation, the prisoner population in Colorado has now been falling each year since 2009 and is expected to continue to do so well into the future. This is the type of costeffective, innovative thinking that often comes about when voters say no to continued prison and jail expansion.

Unfortunately, it came too late for taxpayers this time.

Even though the newly constructed Colorado State Penitentiary II will be closing and left empty a mere 18 months or so after its grand opening, taxpayers will still be spending $18 million a year in lease payments to the investors holding the COPs until the year 2021.

While the state legislature could legally refuse to authorize any further lease payments — after all, that’s why COPs aren’t considered debt — it won’t happen. Refusing to reauthorize the annual lease payment would leave the COP investors holding the bag, and the state wouldn’t be able to float future COPs to bypass voters for the next building project. While such a default would be a good outcome for taxpayers — if it limited the state’s ability to sell future COPs — it would be an unacceptable imposition for the politicians, investment bankers and investors who currently enjoy and profit handsomely from this new system where public debt and high-interest payments have been magically transformed into a simple lease.